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Navigating Uncertainty

Our Perspective As We Begin The Fourth Quarter

In recent weeks, the market has experienced several rounds of volatility, spurred by a number of factors. As we begin the fourth quarter of 2021,we wanted to break down the key economic stories we are monitoring, along with our perspective on how to navigate this most recent round of market volatility. As always, we invite you to connect with our team if you have any questions about the ideas or perspectives shared.

 

Key factors we are monitoring as we begin the fourth quarter

There are many moving pieces to the current market environment, but the biggest factors are tax policy, inflation, political uncertainty, and Fed policy.

 

Tax law changes

There are a number of proposed changes to the tax code being debated in Washington D.C., but the following proposals are, in our view, the most notable:

  • Increasing the top income tax rate and lowering the threshold for the top bracket.[1]
  • Increasing capital gains tax rates to align with income tax rates
  • Creating a progressive estate tax that starts at 45% on estates valued over $3.5 million and rises to 65% on estates valued over $1 billion.[2]
  • Eliminating the basis reset on inherited assets.[3]

 

Inflation

The Consumer Price Index (CPI) showed a 0.4% increase in inflation in September, which represents a 5.4% increase year-over-year.[4] Inflation has been an ongoing concern for investors and economists alike, and recent supply chain issues have led to shortages and price hikes that have further complicated the inflation outlook.

 

Uncertainty in Washington D.C.

Negotiations on raising the debt ceiling stalled in the past few weeks, and although an agreement was eventually reached that allowed the U.S. to avoid defaulting on its debts,[5] the contentious nature of the negotiations could still shake investor confidence. In addition, the infrastructure package that includes a number of measures aimed at revamping American infrastructure have stalled.[6]

 

The Federal Reserve

The Fed has remained very accommodative in recent quarters, continuing to purchase bonds and keeping interest rates low. Questions remain about how a tightening of policy (a reduction of bond buying and increasing Fed Funds rate) would impact the market.

Without a doubt, there is uncertainty in the market today, and we will be monitoring each of these factors closely as we begin the fourth quarter. Our 30-years of experience navigating investment markets has shown us that this moment—just like past moments of volatility—requires a disciplined approach. The first step in doing that, is to understand how moments of uncertainty can influence our decision-making process.

 

How uncertainty impacts decision-making

In the face of uncertainty, it’s common to feel an urge to do something: realize capital gains, de-risk your portfolio, or deviate from your asset allocation strategy. This desire to act—rather than stick to a well-developed plan— is a form of unconscious bias known as “uncertainty avoidance” or “ambiguity aversion,”[7] which leads us to prefer known outcomes over unknown ones—even if the known outcome is not a positive one.

Ambiguity bias is also related to recency bias, which leads us to think that whatever happened most recently is most likely to continue into the future.[8] So when stock prices are going up, recency bias leads us to think they will continue to go up; when they’re going down, we can’t help but assume that they will continue to decline.

With the S&P 500 recently experiencing a 5% correction from its peak in September, now is an important time to take a step back and consider the role that recency bias or ambiguity bias may be playing in your decision-making process. This is sound advice for everyone, not just investors. As wealth managers, we continually remind ourselves of these biases and how they can impact long-term outcomes.

 

The best thing to do: stay focused on your asset allocation strategy

At Sound View, we like to say that your asset allocation strategy should be a blend of your risk tolerance and your goals. If your risk tolerance hasn’t changed recently, and your long-term financial goals haven’t changed either, then this recent round of volatility is likely not a good reason to deviate from your defined strategy.

 

After all, this isn’t the first time we have seen volatility, nor will it be the last: between 1948 and 2017, the S&P 500 averaged nearly three 5% corrections per year, one 10% correction per year, and one 15% correction every 3.5 years.[9] This goes to show that, while a bit uncomfortable, the current volatility we are experiencing is not unusual for the long-term investor.

In fact, market volatility usually only poses a risk to our long-term wealth trajectory when it causes us to react, and studies have also shown how volatility-driven decision making can negatively impact long-term investment performance: Between 1999 and 2019, the S&P 500 outperformed the average investor by nearly 2.00% per year. The key difference? Biases and emotions, which encouraged investors to try and time the market or deviate from their asset allocation strategy.[10]

 

Closing thoughts

We understand how challenging it can be to stay focused on the big picture during periods of market volatility. Over the coming months, we will continue to closely monitor capital markets and any legislative or policy developments that may impact markets, and we will keep you informed about tax law developments that may impact your wealth management or estate planning strategy.

The team at Sound View has seen a lot over the last 30-plus years in the investment markets, and regardless of what the future holds, we will be with you every step of the way.

 

ABOUT THE AUTHOR: Emerson Ham, III, CIMA®, CFP®, CPWA®

Emerson co-founded Sound View Wealth Advisors to serve clients in an objective, transparent and independent environment. An investment strategist and portfolio designer, he creates tailored portfolios that reflect each client’s objectives, risk tolerance, time horizons and investment preferences.

Prior to Sound View Wealth Advisors, Emerson had a 26-year career at Merrill Lynch, where he was a co-founder of the Bouchillon, Ham & Dekle Group, serving as investment strategist and portfolio designer. He is a Certified Financial Planner™, a Certified Investment Management Analyst®, a Certified Private Wealth Advisor® and a member of The Financial Planning Association.

 

 

 

Disclaimer: The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute personalized legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Information obtained from third party sources are believed to be reliable but not guaranteed. Sound View Wealth Advisors Group, LLC makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

 

[1]  Tax Foundation, Details and Analysis of Tax Proposals in President Biden’s American Families Plan. (Link)

[2] CNBC, Bernie Sanders introduces bills to hike taxes on corporations and the wealthiest Americans. (Link)

[3]  The Patriot Ledger, The proposed STEP Act and what it means to you. (Link)

[4] Reuters, High inflation squeezing U.S. consumers as food prices, rents accelerate. (Link)

[5] Reuters, Biden signs bill raising U.S. debt limit, averting default. (Link)

[6] Congress.gov, Infrastructure Investment and Jobs Act. (Link)

[7] Sixth Factor, Does Ambiguity Aversion bias affect investors’ decisions? (Link)

[8] Morningstar, Is Recency Bias Swaying Your Investing Decisions? (Link)

[9] Capital Group, Correction or bear? 6 charts that explain market declines (link)

[10] The Balance, Why Average Investors Earn Below Average Market Returns (link)